Investments must meet sole purpose test

Because their funds can at times have a high level of cash, do-it-yourself super fund trustees are sometimes attracted to the idea of utilising this resource in a more sophisticated investment enterprise than simply buying an asset.

While the money in DIY funds is certainly meant to be put to good investment use, there are restrictions on certain activities that if pursued could get a fund into a lot of trouble.

One such activity illustrated by a reader question concerned a joint venture residential apartments property development where the DIY fund’s role, according to the reader, was to provide most of the finance.

Although the specific question asked whether the reader and his wife could acquire one of these apartments given the DIY fund’s involvement, super specialist Daniel Butler of DBA Lawyers focused this back to the strategy of the fund providing loan finance to the property development.

There is a problem with this strategy, says Butler, because it appears to suggest that the land on which the development has been carried out is owned by the reader and his wife and the DIY contributed the finance. This is a reasonable assumption, given the reader did not indicate that the land is owned by the fund.

Who owns the land is actually a crucial aspect of the activity, says Butler, given an important rule of law that applies when it comes to property development. This general rule of law is that anything that is affixed to land becomes part of the property owned by the owner of the land. The authority as far as this law is concerned is Megarry & Wade’s The Law of Real Property, published in 2008.

Broadly this rule, explains Butler, would result in the DIY fund having loaned money to the reader and his wife as any improvements would be owned by them as the property owners. Where it can mean trouble is that under superannuation law, a super fund is not allowed to lend money to a member or a relative of a member.

There is an important concept in superannuation law known as the sole purpose test, which states that the sole purpose of superannuation should be to provide retirement benefits for members of the fund. If the super fund’s cash was simply used as an easier source of finance to carry out the property development, says Butler, this amounts to a contravention of the sole purpose test. A breach of the sole purpose, he says, carries serious penalties such as potentially rendering the fund non-complying with a 45 per cent tax on the value of the fund apart from a certain tax free amount.

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Instead of being owned by the reader and his wife directly, what if the land was owned by a company they were directors of?

In this case, says Butler, any loan from the DIY fund to the company controlled by the reader would be regarded as a loan to a related party, which is subject to a limit of no more than 5 per cent of the total assets of the fund. So if it was a $1 million super fund, no more than $50,000 could be lent to the company.

This 5 per cent limit is an ongoing restriction that must be continually monitored. Moreover, any DIY fund loan must be properly documented and reflect arm’s length commercial terms.

It’s a different story however, says Butler, if the land is owned by the super fund. While the ideal scenario then is that the super fund also has the money to finance any development, the fund could come to an arrangement to do a joint venture with the members or a related party. The major considerations then are that any financial arrangements are properly documented and occur on an arm’s length commercial basis.

Butler says many people think that joint ventures between members and their DIY super are a simple matter. They are not.

“We generally try to talk people out of arrangements where two sides are likely to involved and recommend instead that they contribute more money to the fund and do it all within the fund," he says.

Even then, issues can arise where a member wishes to use a company they may have to develop the property, without realising it raises related party issues and all transactions must be at arm’s length.

Where trustees of a DIY fund want to be actively involved in developing land that the fund owns, says Butler, they are made to go through the paces of getting independent quotations from builders based on properly documented plans and specifications and making sure any services they plan to provide stack up to those quotations. They also have to be aware that complications can arise when it comes to acquiring building materials and being remunerated in any way for professional or business services they may provide.

Where a DIY fund trustee is a property developer, they can be remunerated if they are appropriately qualified and licensed builders and building is their normal business for supplying the same services to the public. And the remuneration should also be no more favourable to the DIY fund than the trustee might expect from an independent builder in the same circumstances.